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Four Paradoxes That Could Change a Company’s Performance Outlook:Weekend Reading

Declining return on assets (ROA) doesn’t fit with the positive stories commonly reported about company performance and the business environment. The newly released report, Success or Struggle: ROA as a True Measure of Business Performance, produced by Deloitte LLP’s Center for the Edge, addresses four of these seeming paradoxes: rising corporate profits, long-term economic growth, increasing labor productivity and more consumer choice.

The article examines the effects of what the Center terms the “Big Shift” on major components of ROA and the perils of short-term thinking. In addition, the report demonstrates how companies can chart a course back to long-term thinking. What follows is an excerpt from the report, which was written by John Hagel, co-chairman, Deloitte Center for the Edge; John Seely Brown, independent co-chairman, Deloitte Center for the Edge; Tamara Samoylova, head of research, Deloitte Center for the Edge; and Michael Lui, research fellow, Deloitte Center for the Edge.

ROA as a True Measure of Business Performance

The news today paints an upbeat picture on many fronts. Corporations report record profit levels.¹ The economy has recovered at a steady pace of 1.8% to 2.4% over the last three years.² Stock market rallies restored major indices to prior levels and beyond. Housing prices have stabilized and have begun to increase nationally.³ Manufacturing activity is showing signs of expansion.⁴ All aggregate signs point to positive outcomes for the time being.

John Hagel, co-chairman, Deloitte LLP Center for the Edge

Yet, other metrics tell a different story, one of increasing pressures and stress for companies, executives and employees. An increasing topple rate indicates that U.S. companies are struggling to maintain their leadership positions as revenues and market share prove vulnerable.⁵ Over the past four years, Chapter 11 business bankruptcies have been at a level not seen since the mid-1990s.⁶ High-profile bankruptcies, such as Linen n’ Things and Blockbuster, and the automobile industry crisis in 2008 highlight the potential for seemingly successful companies to suffer rapid, irrecoverable downturns.

Even without the financial meltdown of 2008, the last several decades of rapid technological change and increasing global economic liberalization have put increasing pressure on traditional business models. These pressures are felt by executives charged with pursuing profitable growth and workers who must stay relevant as technology and business models change. The cumulative effects of long-term changes, driven by digital technology and public policy shifts, which are transforming the global business economy, comprise an era that The Center for the Edge calls the “Big Shift.”

This story is embodied in the economy-wide, secular decline in return on assets over the last 47 years. The decline signals companies’ decreasing ability to find and capture attractive opportunities relative to the assets they have. Companies lack a clear vision or the ability and commitment to execute a long-term strategy. The long-term trajectory of ROA, rather than a snapshot in any given quarter or year, reveals how effective a company is, over time, at harnessing business opportunities in a highly uncertain environment.

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ROA is not a perfect measure, but it is the most effective, broadly available financial measure to assess company performance. It captures the fundamentals of business performance in a holistic way, looking at both income statement performance and the assets required to run a business. Commonly used metrics such as return on equity or returns to shareholders are vulnerable to financial engineering, especially through debt leverage, which can obscure the fundamentals of a business. ROA is less vulnerable to the kind of short-term gaming that can occur on income statements since many assets, such as property, plant and equipment as well as intangibles, involve long-term asset decisions that are more difficult to tamper with in the short term.

In the report, the authors examine how executives can better understand their companies’ long-term ROA and how “looking back” can help make smarter decisions for the future.

Based on the analysis of 47 years of data, the report demonstrates how ROA depicts the so-called Big Shift—the cumulative effect of long-term changes driven by digital technology and public policy shifts that are transforming the global business economy.

More consumer choice: Leads to increases in product development spending.

Long-term economic growth: Companies must be more creative in finding ways to capture value.

From these paradoxes, executives can learn several lessons. First, a new mindset is needed to shift from a short-term to a longer-term view of performance. Also, conducting an historical ROA analysis can help companies develop a longer-term mindset which can help prioritize efforts, steer strategic decisions and minimize distraction from short-term events. In addition, an examination of ROA leads to implications for talent development, customer relations and value creation.

Read the full report to learn more about the four paradoxes related to ROA that are part of today’s business environment, and why good numbers aren’t always good news.

Note, the report is part of the Shift Index, designed to help executives understand and take advantage of the long-term forces of change shaping the U.S. economy. The Shift Index tracks 25 metrics across more than 40 years. These metrics fall into three areas: 1) the developments in the technological and political foundations underlying market changes, 2) the flows of capital, information, and talent changing the business landscape and 3) the impacts of these changes on competition, volatility and performance across industries. Combined, these factors reflect what the Center for the Edge, part of Deloitte LLP, calls the Big Shift in the global business environment. For more information, please go to www.deloitte.com/us/shiftindex.

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